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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 000-32403
NCO PORTFOLIO MANAGEMENT, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 23-3005839
- --------------------------------- ------------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1705 Whitehead Road, Baltimore, Maryland 21207-4004
----------------------------------------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (410) 594-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's common stock as of November
14, 2002 was 13,576,519.
NCO PORTFOLIO MANAGEMENT, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets
As of December 31, 2001 and September 30, 2002............................................. 3
Consolidated Statements of Income
For the Three and Nine Months Ended September 30, 2001 and 2002............................ 4
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2001 and 2002...................................... 5
Notes to Consolidated Financial Statements................................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................................ 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 19
Item 4. Controls and Procedures......................................................................... 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 21
Item 2. Changes in Securities and Use of Proceeds....................................................... 21
Item 3. Defaults Upon Senior Securities................................................................. 21
Item 4. Submission of Matters to a Vote of Security Holders............................................. 21
Item 5. Other Information............................................................................... 21
Item 6. Exhibits and Reports on Form 8-K................................................................ 21
SIGNATURES.............................................................................................. 22
CERTIFICATIONS.......................................................................................... 23
Part 1 - Financial Information
Item 1 - Financial Statements
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Balance Sheets
(Amounts in thousands, except par values)
December 31, September 30,
2001 2002
ASSETS (Unaudited)
------------ ------------
Cash and cash equivalents $ 6,509 $ 5,555
Restricted cash 1,125 900
Purchased accounts receivable 136,339 145,561
Investment in securitization 7,312 7,417
Deferred income taxes 992 --
Deferred costs 651 499
Other assets 784 3,210
-------- --------
Total assets $153,712 $163,142
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable $ 73 $ 171
Accrued expenses 2,861 3,770
Accrued compensation and related expenses 405 353
Notes payable 45,379 57,212
Notes payable - affiliates 47,130 33,880
Deferred income taxes -- 3,090
-------- --------
Total liabilities 95,848 98,476
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized,
no shares issued and outstanding -- --
Common stock, $.01 par value, 35,000 shares authorized,
13,576 shares issued and outstanding 136 136
Additional paid-in capital 40,826 40,826
Retained earnings 16,902 23,704
-------- --------
Total stockholders' equity 57,864 64,666
-------- --------
Total liabilities and stockholders' equity $153,712 $163,142
======== ========
See accompanying notes.
3
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
2001 2002 2001 2002
-------- -------- -------- --------
Revenue $ 16,189 $ 16,338 $ 46,723 $ 46,716
Operating costs and expenses:
Payroll and related expenses 525 328 1,333 1,431
Servicing fee expenses 7,347 8,932 20,693 25,296
Selling, general, and administrative expenses 412 715 1,507 2,087
Amortization expense 75 78 175 228
Impairment of purchased accounts receivable 1,321 398 1,784 1,596
-------- -------- -------- --------
Total operating costs and expenses 9,680 10,451 25,492 30,638
-------- -------- -------- --------
Income from operations 6,509 5,887 21,231 16,078
Other income (expense):
Interest and other income 41 135 159 569
Interest expense (2,226) (2,143) (6,099) (5,762)
-------- -------- -------- --------
Total other income (expense) (2,185) (2,008) (5,940) (5,193)
-------- -------- -------- --------
Income before income tax expense 4,324 3,879 15,291 10,885
Income tax expense 1,621 1,455 5,734 4,083
-------- -------- -------- --------
Net income $ 2,703 $ 2,424 $ 9,557 $ 6,802
======== ======== ======== ========
Net income per share:
Basic $ 0.20 $ 0.18 $ 0.76 $ 0.50
======== ======== ======== ========
Diluted $ 0.20 $ 0.18 $ 0.76 $ 0.50
======== ======== ======== ========
Weighted average shares outstanding:
Basic 13,576 13,576 12,636 13,576
Diluted 13,576 13,576 12,636 13,577
See accompanying notes.
4
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
For the Nine Months
Ended September 30,
-------------------------
2001 2002
-------- --------
Cash flows from operating activities:
Net income $ 9,557 $ 6,802
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred costs 175 229
Impairment of purchased accounts receivable 1,784 1,596
Income from investment in securitization -- (105)
Equity income from investment in joint venture -- (375)
Changes in operating assets and liabilities, net of acquisition:
Restricted cash 2,555 225
Deferred income taxes 6,335 4,083
Other assets 829 (13)
Accounts payable and accrued expenses (3,788) 8
-------- --------
Net cash provided by operating activities 17,447 12,450
-------- --------
Cash flows from investing activities:
Purchases of accounts receivable (38,920) (49,085)
Collections applied to principal on purchased accounts receivable 25,951 37,151
Purchase price adjustments applied to principal on purchased accounts receivable -- 3,197
Investment in joint venture, net -- (2,038)
Net cash paid for pre-acquisition liabilities and acquisition related costs (11,077) --
-------- --------
Net cash used in investing activities (24,046) (10,775)
-------- --------
Cash flows from financing activities:
Borrowings (repayments) under NCO Group credit facility, net 47,130 (13,250)
Borrowings of notes payable -- 20,610
Repayments on notes payable (35,445) (9,912)
Payment of fees to acquire new debt (901) (77)
Issuance of common stock 2,320 --
-------- --------
Net cash provided by (used in) financing activities 13,104 (2,629)
-------- --------
Net increase (decrease) in cash and cash equivalents 6,505 (954)
Cash and cash equivalents at beginning of period -- 6,509
-------- --------
Cash and cash equivalents at end of period $ 6,505 $ 5,555
======== ========
See accompanying notes.
5
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note A - Organization and Business
NCO Portfolio Management, Inc. ("NCO Portfolio" or the "Company") was
incorporated in Delaware on January 22, 1999 (date of inception) under the name
of NCO Portfolio Funding, Inc. The Company changed its name from NCO Portfolio
Funding, Inc. to NCO Portfolio Management, Inc. in February 2001. NCO Portfolio
purchases and manages defaulted consumer accounts receivable from consumer
creditors such as banks, finance companies, retail merchants and other consumer
oriented companies. NCO Portfolio's purchased accounts receivable originate from
consumers located throughout the United States. NCO Portfolio has funded its
purchased accounts receivable through internal cash flows, financing from NCO
Group, Inc. ("NCO Group" or the "Parent") and other financing arrangements. NCO
Portfolio was a wholly owned subsidiary of NCO Group until NCO Portfolio's
merger with Creditrust Corporation ("Creditrust") on February 20, 2001 (the
"Merger"). In connection with the Merger, NCO Portfolio became a publicly traded
company (NASDAQ: NCPM). Included in the Statements of Income are the results of
operations of the net assets acquired in the Merger with Creditrust for the
period from February 21, 2001 through September 30, 2001 and for the nine months
ended September 30, 2002.
As part of the Merger, NCO Portfolio entered into a ten-year service agreement
that appointed a wholly owned subsidiary of NCO Group, NCO Financial Systems,
Inc. ("NCOF") as the provider of collection services to NCO Portfolio. NCO Group
has agreed to offer all of its future U.S. accounts receivable purchase
opportunities to NCO Portfolio. Additionally, NCO Group amended its credit
agreement with Citizens Bank of Pennsylvania ("Citizens Bank") to provide a
credit facility to NCO Portfolio in the form of a sub-facility (See Note H).
During the quarter ended September 30, 2002, all disputed claims and
administrative costs related to the bankruptcy of Creditrust were substantially
resolved and, based upon such final determination, NCO Group now owns 63.347% of
the outstanding NCO Portfolio common stock.
Note B - Summary of Significant Accounting Policies
Basis of Accounting
The consolidated financial statements and disclosures included herein for the
three and nine months ended September 30, 2001 and 2002 are unaudited. These
consolidated financial statements and disclosures have been prepared by the
Company in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of adjustments of a normal and recurring nature) considered necessary for a fair
presentation have been included. Operating results for the three and nine month
periods ended September 30, 2002 are not necessarily indicative of the results
that may be expected for the year ended December 31, 2002. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on March 19, 2002.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
all affiliated subsidiaries and entities controlled by the Company. All
significant intercompany accounts and transactions have been eliminated. Two
affiliates that the Company does not control are InoVision-MEDCLR-NCOP Ventures,
LLC and Creditrust SPV98-2, LLC ("SPV 98-2") and are not included in the
consolidated financial statements (See Note E).
Cash and Cash Equivalents and Restricted Cash
NCO Portfolio considers all highly liquid securities purchased with an initial
maturity of three months or less to be cash equivalents. One securitization that
is accounted for as a secured borrowing has provisions that restrict NCO
Portfolio's use of cash. Restricted cash as of December 31, 2001 and September
30, 2002 was $1.1 million and $900,000, respectively.
6
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note B - Summary of Significant Accounting Policies (Continued)
Purchased Accounts Receivable
NCO Portfolio accounts for its investment in purchased accounts receivable on an
accrual basis under the guidance of the American Institute of Certified Public
Accountants' Practice Bulletin No. 6, "Amortization of Discounts on Certain
Acquired Loans," using unique and exclusive portfolios. Portfolios are
established with accounts having similar attributes. Typically, each portfolio
consists of an individual acquisition of accounts. Once a portfolio is acquired,
the accounts in the portfolio are not changed. Proceeds from the sale of
accounts within a portfolio are accounted for as collections in that portfolio.
Collections on replacement accounts received from the originator of the loans
are included as collections in the corresponding portfolios. The discount
between the cost of each portfolio and the face value of the portfolio is not
recorded since NCO Portfolio expects to collect a relatively small percentage of
each portfolio's face value.
Each portfolio is initially recorded at cost, which includes the external costs
of acquiring portfolios. Collections on the portfolios are allocated to revenue
and principal reduction based on the estimated internal rate of return ("IRR")
for each portfolio. The IRR for each portfolio is estimated based on the
expected monthly collections over the estimated economic life of each portfolio
(generally five years, based on NCO Portfolio's collection experience), compared
to the original purchase price. Revenue on purchased accounts receivable is
recorded monthly based on each portfolio's effective IRR for the quarter applied
to each portfolio's monthly opening carrying value. To the extent collections
exceed the revenue, the carrying value is reduced and the reduction is recorded
as collections applied to principal. Because the IRR reflects collections for
the entire economic life of the portfolio, and those collections are not
constant, lower collection rates, typically in the early months of ownership,
can result in a situation where the actual collections are less than the revenue
accrual. In this situation, the carrying value of the portfolio may be increased
for the difference between the revenue accrual and collections.
To the extent the estimated future cash flow increases or decreases from the
expected level of collections, NCO Portfolio prospectively adjusts the IRR
accordingly. If the carrying value of a particular portfolio exceeds its
expected future cash flows, a charge to income would be recognized in the amount
of such impairment. Additional impairments on each quarters' previously impaired
portfolios may occur if the current estimated future cash flow projections,
after being adjusted prospectively for actual collection results, is less than
the carrying valves recorded. After the impairment of a portfolio, no revenue is
recorded on that portfolio and collections are recorded as a return of capital
until the full carrying value of the portfolio has been recovered. Once the full
cost of the carrying value has been recovered, all collections will be recorded
as revenue. The estimated IRR for each portfolio is based on estimates of future
cash flows from collections, and actual cash flows will vary from current
estimates. The difference could be material.
Third party legal and professional fees incurred with respect to the acquisition
of purchased accounts receivable are capitalized as part of the cost of the
portfolio, and amortized over the life of the portfolio. For the quarter ended
September 30, 2002, legal and professional fees of $154,000 were capitalized and
included in the cost of purchased accounts receivable.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes.
In the ordinary course of accounting for purchased accounts receivable,
estimates are made by management as to the amount and timing of future cash
flows expected from each portfolio. The estimated future cash flow of each
portfolio is used to compute the IRR for the portfolio. The IRR is used to
allocate cash flow between revenue and principal reduction of the carrying value
of purchased accounts receivable.
On an ongoing basis, the Company compares the historical trends of each
portfolio to projected collections. The future projections are then increased or
decreased, within parameters, in accordance with the historical trend. The
results are further reviewed by management with a view towards specifically
addressing any particular portfolio's performance. Actual results will differ
from these estimates and a material change in these estimates could occur within
one year. (See note D)
7
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note B - Summary of Significant Accounting Policies (Continued)
Investments in Debt and Equity Securities
NCO Portfolio accounts for investments, such as the investment in
securitization, SPV 98-2, in accordance with Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." As such, investments are recorded as either trading, available for
sale, or held to maturity based on management's intent relative to those
securities. NCO Portfolio records its investment in securitization as an
available for sale debt security. Such security is recorded at fair value, and
unrealized gains and losses, net of taxes, are not reflected in income but are
recorded as other comprehensive income in stockholders' equity until realized. A
decline in the value of an available for sale security below cost that is deemed
other than temporary is charged to earnings as an impairment and results in the
establishment of a new cost basis for the security.
The investment in securitization represents the residual interest in a
securitized pool of purchased accounts receivable acquired in the Merger. The
investment in securitization accrues interest at an effective yield (IRR), which
is estimated based on the expected monthly collections over the estimated
economic life of the investment (approximately five years). The carrying cost of
this investment approximates fair value at September 30, 2002 (See note E).
Income Taxes
NCO Portfolio was included in NCO Group's consolidated Federal income tax return
prior to the effective date of the Merger. Effective for periods after
consummation of the Merger, NCO Portfolio files its own Federal income tax
return. The Company accounts for income taxes using an asset and liability
approach. The asset and liability approach requires the recognition of deferred
tax assets and liabilities for expected future tax consequences of temporary
differences between the financial reporting and tax basis of assets and
liabilities.
The portfolios of purchased accounts receivable are composed of distressed debt.
Collection results are not guaranteed until received; accordingly, for tax
purposes, any gain on a particular portfolio is deferred until the full cost of
its acquisition is recovered. Revenue for financial reporting purposes is
recognized over the life of the portfolio. Deferred tax liabilities arise from
deferrals created during the early stages of the portfolio. These deferrals
reverse after the cost basis of the portfolio is recovered. In general, the
creation of new tax deferrals from future purchases of portfolios are likely to
offset the reversal of the deferrals from portfolios where the collections have
become fully taxable.
Deferred Costs
NCO Portfolio capitalizes legal and professional fees incurred in connection
with the issuance of new debt as it relates to the acquisition of purchased
accounts receivable. NCO Portfolio capitalized $901,000 and $77,000 in costs
incurred in connection with its establishment of the NCO Group credit
sub-facility and a note payable issued in August 2002, respectively. These costs
are being amortized over the terms of the facilities, which are thirty-six and
twenty-four months, respectively.
8
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note C - Earnings per Share
Basic earnings per share ("EPS") was computed by dividing the net income for the
three and nine months ended September 30, 2001 and 2002, by the weighted average
number of common shares outstanding. Diluted EPS was computed by dividing the
net income for the three and nine months ended September 30, 2001 and 2002, by
the weighted average number of common shares outstanding plus all common
equivalent shares. Outstanding options have been utilized in calculating diluted
net income per share only when their effect would be dilutive. There were
460,000 and 593,000 options outstanding to purchase shares of common stock at
September 30, 2001 and 2002, respectively.
The reconciliation of basic to diluted weighted average shares outstanding for
the three and nine months ended September 30, 2001 and 2002 was as follows
(amounts in thousands):
For the three months ended For the nine months ended
September 30, September 30,
-------------------------- -------------------------
2001 2002 2001 2002
---- ---- ---- ----
Basic 13,576 13,576 13,576 13,576
Dilutive effect of options -- -- -- 1
------ ------ ------ ------
Diluted 13,576 13,576 13,576 13,577
====== ====== ====== ======
Note D - Purchased Accounts Receivable
NCO Portfolio purchases defaulted consumer accounts receivable at a discount
from the actual principal balance. The following summarizes the change in
purchased accounts receivable for the year ended December 31, 2001, and for the
nine months ended September 30, 2002 (amounts in thousands):
2001 2002
--------- ---------
Balance, at beginning of period.................................................. $ 31,480 $ 136,339
Purchased accounts receivable acquired from the Merger ..... 93,518 --
Purchases of accounts receivable............................ 48,149 51,166
Collections on purchased accounts receivable................ (97,088) (83,064)
Purchase price adjustments.................................. -- (4,000)
Revenue recognized.......................................... 62,929 46,716
Impairment of purchased accounts receivable................. (2,649) (1,596)
--------- ---------
Balance, at end of period........................................................ $ 136,339 $ 145,561
========= =========
During the three months ended September 30, 2001 and 2002, impairments of $1.3
million and $398,000, respectively, were recorded as a charge to income on
portfolios where the carrying values exceeded the expected future cash flows.
For the nine months ended September 30, 2001 and 2002, impairments of $1.8
million and $1.6 million, respectively, were recorded as a charge to income on
portfolios where the carrying values exceeded the expected future cash flows. No
revenue will be recorded on these portfolios until their carrying values have
been fully recovered. As of September 30, 2002, the combined carrying values on
all impaired portfolios aggregated $6.5 million, or 4.5% of purchased accounts
receivable, representing their net realizable value. During the three months
ended September 30, 2002, the Company concluded a contract re-negotiation with
the seller of several existing portfolios resulting in a $4 million cash price
reduction on several purchases from 2000 and 2001. The re-negotiation included a
purchase price adjustment as well as a reimbursement for estimated lost
earnings. The $4 million proceeds were recorded as a reduction to purchase price
of the affected portfolios in the quarter ended September 30, 2002. On several
previously impaired portfolios, the cash price reduction reduced the carrying
value of such portfolios, resulting in the cost of certain of the portfolios
becoming fully recovered. Included in revenue for the three and nine months
ended September 30, 2002 was $803,000 of revenue from these fully cost recovered
portfolios. Revenue of approximately $354,000 was recorded during the quarter
ended September 30, 2002 on several non-impaired portfolios due to the improved
IRRs as a result of the cash price reduction. Additionally, included in
collections for the three and nine months ended September 30, 2002 was $1.7
million received as a partial payment on the sale of certain accounts to a
leading credit card issuer.
9
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note E - Investments in Unconsolidated Subsidiaries
NCO Portfolio owns a 100% retained residual interest in an investment in
securitization, SPV 98-2, which was acquired in the Merger. This transaction
qualified for gain on sale accounting when the purchased accounts receivable
were originally securitized by Creditrust. SPV 98-2 issued a note that is due
the earlier of January 2004 or satisfaction of the note from collections, and
had an outstanding balance of $3.1 million as of September 30, 2002. The
retained interest represents the present value of the residual interest in SPV
98-2 using discounted future cash flows after the securitization note is fully
repaid, plus a cash reserve. As of September 30, 2002, the investment in SPV
98-2 was $7.4 million, composed of $4.1 million in present value of discounted
residual cash flows plus $3.3 million in cash reserves. The investment accrues
non-cash income at a rate of 8% per annum on the residual cash flow component
only. The income earned increases the investment balance until the
securitization note has been repaid. After repayment of the note, collections
are split between income and amortization of the investment in SPV 98-2 based on
the discounted cash flows. NCO Portfolio recorded $30,000 and $105,000 of income
on this investment for the three and nine months ended September 30, 2002,
respectively. The off-balance sheet cash reserves of $3.3 million plus the first
$1.2 million in residual cash collections received, after the securitization
note has been repaid, have been pledged as collateral against the Warehouse
Facility (See Note F).
NCO Portfolio has a 50% ownership interest in a joint venture,
InoVision-MEDCLR-NCOP Ventures, LLC ("Joint Venture"), with IMNV Holdings, LLC
("IMNV"). This Joint Venture was established in 2001 to purchase utility,
medical and various other small balance accounts receivable and is accounted for
using the equity method of accounting. Included in other assets on the balance
sheet is the Company's investment in the Joint Venture of $3 million as of
September 30, 2002. Included in the Statement of Income, in "other income," is
$72,000 and $375,000 for the three and nine months ended September 30, 2002,
respectively, representing the Company's 50% share of operating income from this
unconsolidated subsidiary. The Joint Venture has access to capital through a
specialty finance lender who, at its option, lends 90% of the value of the
purchased accounts receivable to the Joint Venture. The debt is
cross-collateralized by all portfolios within the Joint Venture in which the
lender participates, and is non-recourse to NCO Portfolio and IMNV. The
following table summarizes the financial information of the Joint Venture as of
and for the nine months ended September 30, 2002 (amounts in thousands):
Total assets............................... $ 10,868
Total liabilities.......................... $ 4,969
Revenue.................................... $ 6,732
Net income................................. $ 750
Note F - Notes Payable
NCO Portfolio assumed four securitized notes payable in connection with the
Merger, of which one was included in an unconsolidated subsidiary, SPV98-2 (See
Note E). The remaining three notes are included on the balance sheet under notes
payable. These notes payable were originally established to fund the purchase of
accounts receivable. Each of the notes payable is non-recourse to the Company
and NCO Group, is secured by a pool of purchased accounts receivable, and is
bound by an indenture and servicing agreement. Pursuant to the Merger, the
trustee appointed NCOF as the successor servicer for each portfolio of purchased
accounts receivable within these securitized notes. When the notes payable were
established, a separate non-recourse special purpose finance subsidiary was
created to house the assets and issue the debt. These are term notes without the
ability to re-borrow. Monthly principal payments on the notes equal all
collections after servicing fees, collection costs, interest expense and
administrative fees.
The first securitized note ("Warehouse Facility") was established in September
1998 through Creditrust Funding I LLC, a special purpose finance subsidiary. The
Warehouse Facility carries a floating interest rate of LIBOR plus 0.65% per
annum, and the final due date of all payments under the facility is the earlier
of March 2005, or satisfaction of the note from collections. A $900,000
liquidity reserve is included in restricted cash as of September 30, 2002, and
is restricted as to use until the facility is retired. Interest expense, trustee
fees and guarantee fees aggregated $271,000 and $155,000 for the three months
ended September 30, 2001 and 2002, respectively. Interest expense, trustee fees
and guarantee fees aggregated $744,000 and $483,000 for the period from February
21, 2001 to September 30, 2001 and the nine months ended September 30, 2002,
respectively. As of September 30, 2002, $15.9 million was outstanding on this
facility. The note insurer, Radian Asset Assurance Inc., formerly Asset Guaranty
Insurance Company, has been guaranteed against loss by the Company for up to
$4.5 million, which will be reduced if and when cash reserves and residual cash
flows from another securitization, SPV 98-2, are posted as additional collateral
for this facility.
10
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note F - Notes Payable (Continued)
The second securitized note ("SPV99-1 Financing") was established in August 1999
through Creditrust SPV99-1, LLC, a special purpose finance subsidiary. SPV99-1
Financing carried interest at 9.43% per annum, with a final payment date of the
earlier of August 2004, or satisfaction of the note from collections. In May
2002, the note was paid off, and the $225,000 liquidity reserve was returned to
the Company. Interest expense and trustee fees aggregated $177,000 for the three
months ended September 30, 2001. Interest expense and trustee fees aggregated
$575,000 and $56,000 for the period from February 21, 2001 to September 30, 2001
and for the nine months ended September 30, 2002, respectively.
The third securitized note ("SPV99-2 Financing") was established in August 1999
through Creditrust SPV99-2, LLC, a special purpose finance subsidiary. SPV99-2
Financing carries interest at 15% per annum, with a final payment date of the
earlier of December 2004, or satisfaction of the note from collections. Interest
expense and trustee fees aggregated $1 million and $796,000 for the three months
ended September 30, 2001 and 2002, respectively. Interest expense and trustee
fees aggregated $2.4 million and $2.5 million for the period from February 21,
2001 to September 30, 2001 and for the nine months ended September 30, 2002,
respectively. As of September 30, 2002, $20.8 million was outstanding on this
facility.
In August 2002, the Company entered into a four-year exclusivity agreement with
CFSC Capital Corp XXXIV ("Cargill"). The agreement stipulates that all purchases
of accounts receivable with a purchase price in excess of $4 million, with
limited exceptions, shall be offered to Cargill for financing at its discretion.
The agreement has no minimum or maximum credit authorization. The Company may
terminate the agreement at any time after twenty-four months for a cost of
$125,000 per month for each month of the remaining four years, payable monthly.
If Cargill chooses to participate in the financing of a portfolio of accounts
receivable, the financing will be at 90% of the purchase price, with floating
interest at Prime plus 3.25%. Each borrowing is due twenty-four months after the
loan is made. Debt service payments equal collections less servicing fees and
interest expense. As additional interest, Cargill will receive a residual of 40%
in perpetuity, which is defined as all cash collections after servicing fees,
floating rate interest, repayment of the note and the initial investment by the
Company, including interest. The financing is non-recourse to NCO Portfolio's
other assets. This loan agreement contains a collections performance
requirement, among other covenants, that, if not met, provides for
cross-collateralization with any other Cargill financed portfolios, in addition
to other remedies. As of September 30, 2002, NCO Portfolio was in compliance
with all required covenants.
In August 2002, the Company purchased accounts receivable from Great Lakes
Collection Bureau, Inc., which was financed through Cargill at 90% of the $22.9
million purchase price, or $20.6 million, with the remaining 10% being funded by
the Company. The final payment date on the note is the earlier of August 2004,
or satisfaction of the note from collections. Interest expense totaled $484,000
for the three months ended September 30, 2002, which includes $287,000 of
accrued interest representing Cargill's 40% residual participation earned. The
effective interest rate on this note, including the residual interest component
was approximately 19% for the three months ended September 30, 2002. As of
September 30, 2002, $19.4 million was outstanding on this facility.
11
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note G - Commitments and Contingencies
Forward-Flow Agreement
NCO Portfolio currently has a fixed price, term agreement ("forward-flow") with
a major financial institution that obligates NCO Portfolio to purchase, on a
monthly basis, portfolios of charged-off accounts receivable meeting certain
criteria. As of September 30, 2002, NCO Portfolio is obligated to purchase
accounts receivable at a maximum of $1.8 million per month through November
2002, with an option to renew for two additional three-month terms. A portion of
the purchase price is deferred for twelve months, including a nominal rate of
interest. NCOG guarantees the forward-flow agreement.
Litigation
NCO Portfolio is party, from time to time, to various legal proceedings
incidental to its business. In the opinion of management, none of these items,
individually or in the aggregate, will have a significant effect on the
financial position, results of operations, cash flows, or liquidity of NCO
Portfolio.
Note H - Related Party Transactions
Servicing Fees
As part of the Merger, NCO Portfolio entered into a ten-year service agreement
that appointed NCOF as the provider of collection services to NCO Portfolio. NCO
Group has agreed to offer all of its future U.S. accounts receivable purchase
opportunities to NCO Portfolio. NCO Portfolio pays NCOF to perform collection
services for its purchased accounts receivable. Generally, NCOF is paid a
commission ranging from 20% to 40% of collections depending on the nature of the
accounts. NCOF may outsource collections. The cost of outsourcing is generally
higher. Management believes that the commission rates paid are reasonable and
are consistent with rates charged by other collection agencies for the same type
of services. Servicing fees paid to NCOF amounted to $7.3 million and $8.9
million for the three months ended September 30, 2001 and 2002, respectively.
Servicing fees paid to NCOF amounted to $20.4 million and $25.3 million for the
nine months ended September 30, 2001 and 2002, respectively. During the quarter
ended September 30, 2002, NCO Portfolio's legal recovery group was transferred
to the NCOF attorney network.
Shared Services
NCO Group paid certain costs on behalf of NCO Portfolio during the three and
nine months ended September 30, 2001 and 2002. NCO Portfolio reimburses NCO
Group in full for these costs. These costs related to certain shared services,
including office space, human resources, insurance, legal, payroll processing,
external reporting, management information systems and certain other
administrative expenses. Shared services amounted to $45,000 and 135,000 for the
three and nine months ended September 30, 2001 and 2002, respectively.
12
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Note H - Related Party Transactions (Continued)
NCO Group Credit Facility
NCO Group has a credit agreement with Citizens Bank, for itself and as
administrative agent for other participating lenders that originally provided
for borrowings up to $350 million, structured as a revolving credit facility.
The borrowing capacity of the revolving credit facility is subject to quarterly
reductions of $5.2 million until maturity, and 50% of the net proceeds received
from any offering of debt or equity. As of September 30, 2002, there was $69.7
million available under the revolving credit agreement. NCO Group's borrowings
are collateralized by substantially all the assets of NCO Group, including its
common stock of NCO Portfolio. Pursuant to the Merger, NCO Portfolio entered
into a credit agreement with NCO Group in the form of a sub-facility under its
existing credit facility. Certain of NCO Portfolio's assets have been pledged to
Citizens Bank and other participating lenders to secure its borrowings under the
sub-facility. The balance under the revolving sub-facility will become due on
May 20, 2004 ("Maturity Date"). The borrowing capacity of the sub-facility is
subject to mandatory reductions including four quarterly reductions of $2.5
million beginning March 31, 2002 through December 31, 2002. Effective March 31,
2003, quarterly reductions of $3.75 million are required until the earlier of
the Maturity Date or the date at which the sub-facility is reduced to $25
million. The maximum borrowing capacity on the sub-facility was reduced to $42.5
million as of September 30, 2002. The NCO Group credit agreement and the NCO
Portfolio sub-facility contain certain financial covenants such as maintaining
net worth and funded debt to earnings before interest, taxes, depreciation, and
amortization ("EBITDA") requirements, and include restrictions on, among other
things, acquisitions and distributions to shareholders. As of September 30,
2002, NCO Group and NCO Portfolio were in compliance with all of the financial
covenants.
The sub-facility carries interest at 2% over NCO Group's underlying rate from
Citizens Bank and other participating lenders, of which 1% is paid to the
lenders and 1% is paid to NCO Group. At the option of NCO Group, NCO Group's
borrowings bear interest at a rate equal to either Citizens Bank's prime rate
plus a margin ranging from 0.25% to 0.50% that is determined quarterly based
upon NCO Group's consolidated funded debt to EBITDA ratio (Citizens Bank's prime
rate was 4.75% at September 30, 2002), or LIBOR plus a margin ranging from 1.25%
to 2.25% depending on NCO Group's consolidated funded debt to EBITDA ratio
(LIBOR was 1.82% at September 30, 2002). The sub-facility contains a provision
which provides Citizens Bank and other participating lenders with an additional
commitment fee of 0.25% per quarter commencing August 20, 2001. This charge will
continue until the sub-facility is reduced to $25 million. NCO Portfolio was
charged an additional 0.25% per quarter on the full commitment for the quarter
ended September 30, 2002, which is included as part of interest expense. NCO
Portfolio is charged a fee on the unused portion of the sub-facility ranging
from 0.13% to 0.38% depending on NCO Group's consolidated funded debt to EBITDA
ratio. As of September 30, 2002, the outstanding balance under the sub-facility
was $33.9 million. Interest expense for the three months ended September 30,
2001 and 2002 amounted to $878,000 and $728,000, respectively. Interest expense
for the period from February 21, 2001 to September 30, 2001 and the nine months
ended September 30, 2002 amounted to $2.2 million and $2.4 million,
respectively.
Note I - Supplemental Cash Flow Information
The following are supplemental disclosures of cash flow information for the nine
months ended September 30, 2001 and 2002 (amounts in thousands):
2001 2002
---- ----
Cash paid for interest.................................................................. $ 5,688 $ 5,439
Non-cash investing and financing activities:
Deferred portion of purchased accounts receivable.............................. $ -- $ 1,135
Acquisition of purchased accounts receivable paid for in October 2002.......... $ -- $ 946
Common stock issued for Creditrust acquisition................................. $ 24,058 $ --
Fair value of assets acquired in Merger........................................ $ 123,978 $ --
Liabilities assumed in the Merger.............................................. $ 109,394 $ --
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements in this report on Form 10Q, including, without limitation,
statements as to the Company's or management's outlook as to financial results
in 2002 and beyond, statements as to the effects of the economy on the Company's
business, statements as to the Company's or management's beliefs, expectations
or opinions, and all other statements in this report on Form 10Q, other than
historical facts, are forward-looking statements, as such term is defined in the
Securities Exchange Act of 1934, which are intended to be covered by the safe
harbors created thereby. Forward-looking statements are subject to risks and
uncertainties, are subject to change at any time, and may be affected by various
factors that may cause actual results to differ materially from the expected or
planned results. In addition to the factors discussed above, certain other
factors, including without limitation, risks relating to growth and future
accounts receivable purchases, risks related to the Company's debt, risks
related to the recoverability of the purchased accounts receivable, risks
related to the use of estimates, risks related to the ability to purchase
accounts receivable at favorable prices in the open market, risks related to
regulatory oversight, risks related to the retention of its senior management
team, risks related to securitization transactions, risks related to the
fluctuation in quarterly results, risks related to NCO Group's ownership control
of the Company, risks related to the dependency on NCO Group for collections,
and other risks detailed from time to time in the Company's filings with the
Securities and Exchange Commission, including the Annual Report on Form 10K,
filed on March 19, 2002, can cause actual results and developments to be
materially different from those expressed or implied by such forward-looking
statements.
A copy of the Annual Report on Form 10-K can be obtained, without charge except
for exhibits, by written request to Richard J. Palmer, Senior Vice President,
Finance/CFO, NCO Portfolio Management, Inc., 1705 Whitehead Road, Baltimore, MD
21207.
Quarter Ended September 30, 2002 Compared to Quarter Ended September 30, 2001
Revenue. Total revenue increased $100,000, or 0.6%, from $16.2 million for the
three months ended September 30, 2001 to $16.3 million for the three months
ended September 30, 2002. The effective interest method is utilized in computing
revenue. Revenue is calculated by multiplying the beginning of the month
carrying value of a portfolio of purchased accounts receivable by the estimated
IRR attributable to that portfolio. The carrying value of each portfolio is
adjusted monthly by the difference between collections and revenue recognized.
If collections are greater than the revenue recognized, the carrying value will
decrease. Conversely, if the revenue recognized is greater than collections, the
carrying value will increase. The IRR is an estimate based upon the expected
monthly collections over the remaining estimated economic life of each portfolio
in conjunction with the carrying value of each portfolio. Collections on
purchased accounts receivable increased $2.3 million, or 8.1%, from $28.4
million for the three months ended September 30, 2001 to $30.7 million for the
three months ended September 30, 2002. Collections increased from the quarter
ended September 30, 2001 compared to 2002 due to the increased amount of
purchased accounts receivable under management, including the August 2002 Great
Lakes Collection Bureau purchase of $22.9 million. Additionally, included in
collections is approximately $1.7 million received as a partial payment on the
sale of certain accounts to a leading credit card issuer. These additional
proceeds included in collections had a marginal impact on revenue as the rate at
which revenue is recognized period to period is not affected at the same rate as
changes in collections due to the effective interest method of computing
revenue. During the three months ended September 30, 2002, we concluded a
contract re-negotiation with the seller of several existing portfolios resulting
in a $4 million cash price reduction on purchases from 2000 and 2001. The $4
million proceeds were recorded as an adjustment to purchase price of the
affected portfolios in the quarter ended September 30, 2002. On several
previously impaired portfolios, the cash price reduction reduced the carrying
value of such portfolios, resulting in the cost of certain of the portfolios
becoming fully recovered. Included in revenue for the three months ended
September 30, 2002 was $803,000 of revenue from these fully recovered
portfolios. Furthermore, revenue of approximately $354,000 was recorded during
the quarter ended September 30, 2002 on several non-impaired portfolios due to
the improved IRRs as a result of the cash price reduction.
Revenue as a percentage of collections was 57% and 53% for the three months
ended September 30, 2001 and 2002, respectively. Revenue as a percentage of
collections can fluctuate period over period due to a number of factors
including:
(i) the relative under- or over-achievement of actual
collections versus the established estimates. Actual collections exceeding
estimates will tend to lower the percentage because revenue is not impacted at
the same rate as the change in collections due to the effective interest method
of computing revenue, and conversely, not meeting collection estimates will tend
to increase the percentage;
(ii) the differences in the composition of portfolios at a
point in time in their life cycle. Over the life cycle of a portfolio, the
percentage will fluctuate due to the variable collection stream. However, in the
aggregate, the percentage of collections recognized as revenue should
approximate the lifetime profit recognized and the remainder is amortized as a
return of capital;
14
(iii) the composition of the targeted IRRs present in all of
the portfolios combined. Fresher purchased accounts receivable (portfolios with
few or no placements to collection agencies prior to purchase) generally have
lower IRRs than purchased accounts receivable that have been placed with
multiple collection agencies prior to purchase. Fresher accounts receivable
typically cost more. However, net of servicing fees, lower IRRs are offset by
lower costs to collect, resulting in similar targeted net returns; and finally,
(iv) collection trends will increase or decrease our expected
IRR. Increases or decreases in collections have the effect of raising or
lowering (within specified parameters) the future collection projections on all
portfolios, which translates into higher or lower IRRs, and in turn, affects the
percentage of collections recognized as revenue.
Revenue as a percentage of collections for this quarter declined principally due
to changes in the composition of purchased accounts receivable in 2002 versus
2001. Purchased accounts receivable acquired in, and subsequent to, the Merger
were acquired at a lower IRR compared to accounts receivable purchased prior to
the Merger. Purchases of accounts receivable made in the latter half of 2001 and
continuing into 2002 have returns that have been targeted lower at the time of
acquisition due to the tougher economic climate facing us in the near term. The
overall percentage was lowered due to a slow-down in collections as a result of
the continued softening economic climate in the first nine months of 2002.
Decreases in collections had the effect of lowering the future projections on
most portfolios, which translated to lower revenue in the current period.
Additionally, the $1.7 million proceeds included in collections had a marginal
impact on revenue as the rate at which revenue is recognized period to period is
not affected at the same rate as changes in collections due to the effective
interest method of computing revenue.
Additionally, portfolios with $6.5 million in carrying value, or 4.5% of
purchased accounts receivable, as of September 30, 2002 have been impaired to
date and placed on cost recovery. Accordingly, no revenue will be recorded on
these portfolios after their impairment until their carrying value has been
fully cost recovered, resulting in a lower percentage of revenue to collections.
However, as mentioned above, certain portfolios recovered their carrying values
during the quarter due to a purchase price re-negotiation, and $803,000 in
revenue was recorded. This revenue had the effect of increasing the percentage
of revenue to collections, which offset somewhat the negative effect of the
impaired portfolios. See impairment of purchased accounts receivable section
below.
Payroll and related expenses. Payroll and related expenses decreased $197,000,
or 37.5%, from $525,000 for the three months ended September 30, 2001 to
$328,000 for the three months ended September 30, 2002. Payroll and related
expenses continue to be a small part of the business model as a percentage of
revenue. However, the decrease in payroll and related expenses is principally
due to the legal recovery group being transferred to the NCOF attorney network,
and a decrease of estimated incentive accruals.
Servicing fee expenses. Servicing fee expenses increased $1.6 million, or 21.9%,
from $7.3 million for the three months ended September 30, 2001 to $8.9 million
for the three months ended September 30, 2002. Servicing fees are paid as a
commission on collections, and include contingency legal fees. Servicing fee
expenses are impacted by the volume of collections on purchased accounts
receivable and the servicing fee rates charged. Servicing fees paid as a
percentage of collections were 25.7% and 29.0% for the quarters ended September
30, 2001 and 2002, respectively. All of the servicing fees were paid to NCOF.
Included in servicing fees for the three months ended September 30, 2002 was
approximately $170,000 in servicing fees paid on the proceeds of $1.7 million
received in connection with the sale of accounts to a leading credit card
issuer. The servicing fee rate of 10% on the proceeds of this non-performing
account sale was in lieu of the standard higher fees provided for under the
intercompany servicing agreement. Adjusting out those proceeds and related
servicing fees, servicing fees as a percentage of revenue for the quarter ended
September 30, 2002 would have been approximately 30.2%. Servicing fees as a
percentage of collections increased from 2001 to 2002 as the composition of
accounts receivable under management has changed and aged over the past twelve
months. In general, the accounts receivable acquired in the Merger have lower
servicing fees as compared to other accounts receivable purchased since the
Merger. The accounts receivable acquired in the Merger were generally older and
had been through multiple placements to collection agencies, and had
demonstrated a track record of producing a stream of cash flows. Accordingly,
the servicing fees agreed to in the ten-year servicing agreement regarding the
Merger assets were lower than would be the case for comparably aged accounts
receivable. As collections on accounts receivable acquired in the Merger
decrease over time (those having lower servicing fee rates), and collections on
new purchases increase due to increased purchases (those having higher servicing
rates), the blended servicing fees from all accounts receivable under management
will increase. Further, NCOF has and may continue to outsource collections in an
attempt to offset negative economic trends, to test itself, and generally to
augment resources. The servicing cost to us resulting from outsourcing is
generally higher on such accounts since they are relatively more difficult to
resolve.
15
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $303,000, or 73.6%, from $412,000 for the
three months ended September 30, 2001 to $715,000 for the three months ended
September 30, 2002. Selling, general and administrative expenses consist
primarily of court costs associated with legal collections, professional fees,
insurance, trustee fees, management fees and office expenses. The increase was
principally attributable to increased court costs associated with legal
collections, professional fees associated with operational compliance activities
and postage in connection with the Graham Leach Bliley Privacy Act.
Impairment of purchased accounts receivable. On an ongoing basis, portfolios are
reviewed to assess the expected future cash flows as they relate to the carrying
values of the purchased accounts receivable. If the estimated future cash flows
are not sufficient to recover the remaining carrying value of a portfolio, an
impairment has occurred and the portfolio must be written down to its net
realizable value. Additional impairments on previously impaired portfolios may
occur if the current estimated future cash flow projection, after being adjusted
prospectively for the trend in actual collection results, is less than the
current carrying value recorded. During the quarters ended September 30, 2001
and 2002, impairment charges of $1.3 million and $398,000, respectively, were
recorded. Once a portfolio is impaired, no revenue will be recorded until the
carrying value has been fully recovered. During the quarter ended September 30,
2002, we concluded a contract re-negotiation with the seller of several existing
portfolios purchased in 2000 and 2001 resulting in a total $4 million cash price
reduction. On several previously impaired portfolios, the cash price reduction
reduced the carrying value of such portfolios, resulting in the cost of certain
of the portfolios becoming fully recovered. Included in revenue for the three
months ended September 30, 2002 was $803,000 of revenue from these fully
recovered portfolios. The combined remaining carrying value of impaired
portfolios aggregated $4.7 million and $6.5 million, or 3.3% and 4.5% of
purchased accounts receivable as of September 30, 2001 and 2002, respectively.
Collections on impaired portfolios for the third quarter of 2001 and 2002
totaled $418,000 and $1.2 million, respectively.
Other income (expense). Other income (expense) consisted principally of interest
expense and decreased $200,000, or 9.1%, from $2.2 million for the three months
ended September 30, 2001 to $2 million for the three months ended September 30,
2002. The marginal decrease was attributable to a decrease of $26.6 million in
outstanding debt related to the notes payable due affiliate and secured debt,
from $97.1 million as of September 30, 2001 to $70.5 million as of September 30,
2002, offset by an increase in notes payable of $21.8 million related to the
acquisition of the Great Lakes portfolio ($20.6 million) and seller financed
purchased accounts receivable ($1.2 million) in connection with the our forward
flow agreement. Offsetting interest expense, included in other income for the
three months ended September 2001 and 2002 is $41,000 and $135,000, respectively
consisting of our 50% interest in the IMNV joint venture accounted for under the
equity method of accounting; income from our 100% interest in a securitization
trust, SPV 98-2, acquired in connection with the Merger; and interest income on
cash balances.
Income tax expense. Income tax expense was recorded at 37.5% of pre-tax income
for the three months ended September 30, 2001 and 2002. Our effective tax rate
may fluctuate as a result of changes in pre-tax income and nondeductible
expenses. Cash payments for taxes are deferred principally due to the book tax
difference of accounting for purchased accounts receivable on the accrual basis
for GAAP and the cost recovery basis for tax reporting.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended
September 30, 2001
Revenue. Total revenue was $46.7 million for the nine months ended September 30,
2001 and 2002. The effective interest method is utilized in computing revenue.
The IRR is an estimate based upon the expected monthly collections over the
remaining estimated economic life of each portfolio in conjunction with the
carrying value of each portfolio. Collections on purchased accounts receivable
increased $9.1 million, or 11.7%, from $78.1 million for the nine months ended
September 30, 2001 to $87.2 million for the nine months ended September 30,
2002. The increase in collections is principally due to the increased amount of
purchased accounts receivable under management, including the August 2002 Great
Lakes purchase of $22.9 million.
While collections increased for the nine months ended September 30, 2001 to
2002, the rate at which revenue is recognized, or the revenue recognition rate,
decreased from 59.9% to 53.6% for the nine months ended September 30, 2001 and
2002, respectively. Although collections increased, revenue remained unchanged
due to the decrease in the revenue recognition rate. Revenue as a percentage of
collections for the nine months ended September 30, 2001 versus 2002 declined
principally due to changes in the composition of purchased accounts receivable
in 2001 versus 2002. Purchased accounts receivable acquired in, and subsequent
to, the Merger were acquired at a lower IRR compared to accounts receivable
purchased prior to the Merger. Purchases of accounts receivable made in the last
quarter of 2001 and the first nine months of 2002 have returns that have been
targeted lower at the time of acquisition due to the tougher economic climate
facing us in the near term. The overall percentage was also lowered due to a
slow-down in collections as a result of the softening economic climate in the
last quarter of 2001 and the first nine months of 2002. Additionally, included
in collections for the nine months ended September 30, 2002 was approximately
$1.7 million received as a partial payment on the sale of certain accounts to a
leading credit card issuer. These additional proceeds included in collections
had a minimal impact on revenue as the rate at which revenue is recognized
period to period is not affected at the same rate as changes in collections due
to the effective interest method of computing revenue.
16
Additionally, portfolios with $6.5 million in carrying value, or 4.5% of
purchased accounts receivable, as of September 30, 2002 have been impaired to
date and placed on cost recovery. Accordingly, no revenue will be recorded on
these portfolios after their impairment until their carrying value has been
fully cost recovered, resulting in a lower percentage of revenue to collections.
However, during the quarter ended September 30, 2002, certain portfolios
recovered their carrying values, and $803,000 in revenue was recorded. This
revenue had the effect of increasing the percentage of revenue to collections,
which somewhat offset the negative effect of the impaired portfolios. See
impairment of purchased accounts receivable section below.
Payroll and related expenses. Payroll and related expenses increased from $1.3
for the nine months ended September 30, 2001 to $1.4 million for the nine months
ended September 30, 2002. The marginal increase was attributable to having a
full staff for the nine months ended September 30, 2002, versus only a partial
staff for the period prior to the Merger, which occurred in the middle of the
quarter ended March 31, 2001. Payroll and related expenses after the Merger
increased as additional staffing was needed to operate as an independent public
company and to manage a significant increase in purchased accounts receivable
from the Merger and internal growth. Additionally, offsetting this increase in
payroll and related expenses was the transfer of the legal recovery group to the
NCOF attorney network, and a decrease of estimated incentive accruals.
Servicing fee expenses. Servicing fee expenses increased $4.6 million, or 22.2%,
from $20.7 million for the nine months ended September 30, 2001 to $25.3 million
for the nine months ended September 30, 2002. Servicing fees are paid as a
commission on collections, and include contingency legal fees. Servicing fee
expenses are impacted by the volume of collections on purchased accounts
receivable and the servicing fee rates charged. Servicing fees paid as a
percentage of collections was 26.5% and 29.0% for the nine months ended
September 30, 2001 and 2002, respectively. Included therein are servicing fees
paid to NCOF which totaled $20.4 million and $25.3 million for the nine months
ended September 30, 2001 and 2002, respectively. Servicing fees as a percentage
of collections increased from 2001 to 2002 as the composition of accounts
receivable under management has changed and aged over the past twelve months. In
general, the accounts receivable acquired in the Merger have lower servicing
fees as compared to other accounts receivable purchased since the Merger. The
accounts receivable acquired in the Merger were generally older and had been
through multiple placements to collection agencies, and had demonstrated a track
record of producing a stream of cash flows. Accordingly, the servicing fees
agreed to in the ten-year servicing agreement were lower than would be the case
for comparably aged accounts receivable. As collections on accounts receivable
acquired in the Merger decrease over time (those having lower servicing fee
rates), and collections on new purchases increase due to increased purchases
(those having higher servicing rates), the blended servicing fees from all
accounts receivable under management will increase. Further, NCOF has and may
continue to outsource collections in an attempt to offset negative economic
trends, to test itself, and generally to augment resources. The servicing cost
to us resulting from outsourcing is generally higher on such accounts since they
are relatively more difficult to resolve.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $600,000, or 40.0%, from $1.5 million for the
nine months ended September 30, 2001 to $2.1 million for the nine months ended
September 30, 2002. Selling, general and administrative expenses consist
primarily of court costs associated with legal collections, professional fees,
insurance, trustee fees, and office expenses. The principal increase was
attributable to a full nine months of costs incurred in 2002 in connection with
being a separate public company, versus no selling, general and administrative
expenses being incurred prior to the Merger, which occurred on February 20,
2001. Additionally, court costs associated with legal collections increased from
2001 to 2002 in an effort to supplement the collections process during this
economic downturn.
Impairment of purchased accounts receivable. During the nine months ended
September 30, 2001 and 2002, impairment charges of $1.8 million and $1.6
million, respectively, were recorded. Additionally, during the quarter ended
September 30, 2002, we concluded a contract re-negotiation with the seller of
several existing portfolios purchased in 2000 and 2001 resulting in a total $4
million cash price reduction. On several previously impaired portfolios, the
cash price reduction reduced the carrying value of the portfolios in question,
resulting in the cost of certain of the portfolios becoming fully recovered.
Included in revenue for the three months ended September 30, 2002 was $803,000
of revenue from these fully cost recovered portfolios. Collections on impaired
portfolios for the nine months ended September 2001 and 2002 totaled $538,000
and $3.1 million, respectively.
17
Other income (expense). Other income (expense) consisted principally of interest
expense and decreased $700,000, or 11.9%, from $5.9 million for the nine months
ended September 30, 2001 to $5.2 million for the nine months ended September 30,
2002. The decrease was attributable to a decrease of $26.6 million in
outstanding debt related to the notes payable due affiliate and secured debt,
from $97.1 million as of September 30, 2001 to $70.5 million as of September 30,
2002, offset marginally by an increase in notes payable of $21.8 million related
to the August 2002 acquisition of the Great Lakes portfolio ($20.6 million) and
seller financed purchased accounts receivable ($1.2 million) in connection with
the our forward flow agreement. Additionally, the cost of borrowing on two
floating rate notes decreased dramatically during the first nine months of 2001
and the favorable rates continued through the nine months ended September 30,
2002. Offsetting interest expense, included in other income for the nine months
ended September 2001 and 2002 is $159,000 and $569,000, respectively consisting
of our 50% interest in the IMNV joint venture accounted for under the equity
method of accounting; income from our 100% interest in a securitization trust,
SPV 98-2, acquired in connection with the Merger; and interest income on cash
balances.
Income tax expense. Income tax expense was recorded at 37.5% of pre-tax income
for the nine months ended September 30, 2001 and 2002. Our effective tax rate
may fluctuate as a result of changes in pre-tax income and nondeductible
expenses. Cash payments for taxes are deferred due principally to the book tax
difference of accounting for purchased accounts receivable on the accrual basis
for GAAP and the cost recovery basis for tax reporting.
Liquidity and Capital Resources
Historically, we have derived all of our cash flow from collections on purchased
accounts receivable and borrowings from NCO Group. Effective with the Merger, we
entered into a credit agreement with NCO Group in the form of a
sub-facility under its existing credit facility. As of September 30, 2002, the
balance on the sub-facility was $33.9 million, with a capacity of $42.5 million,
which is subject to mandatory reductions. As of September 30, 2002, NCO Group
and NCO Portfolio were in compliance with all of the financial covenants.
In August 2002, we entered into a four-year discretionary financing agreement
with Cargill Financial to provide financing for larger purchases of accounts
receivable at 90% of the purchase price. This agreement gives us the leverage
necessary to purchase larger portfolios that we may not otherwise be able to
purchase. This financing agreement is non-recourse to NCOG and our other assets
and has no minimum or maximum credit authorization. As of September 30, 2002,
NCO Portfolio was in compliance with all required covenants.
The debt service requirements associated with borrowings under our secured
credit facilities, including the borrowings for the Great Lakes portfolio, and
the mandatory reductions on our revolving sub-facility have increased liquidity
requirements. The sub-facility provides for mandatory reductions of $2.5 million
per quarter starting March 31, 2002, increasing to $3.75 million per quarter
starting March 31, 2003 until the sub-facility is reduced to $25 million.
However, we anticipate that cash flows from operations will be sufficient to
fund all mandatory reductions on the sub-facility, debt service payments on
secured debt, operating expenses, interest expense and future purchases of
accounts receivable under our existing forward-flow agreement. Cash flows from
operations are directly related to the amount of collections actually received.
Estimates are used to forecast collections and revenue. A decrease in cash flows
from operations due to a decrease in collections from changes in the economy or
the performance of NCOF as service provider, may require us to reduce the amount
of accounts receivable purchased. The effect of reduced accounts receivable
purchases would be a reduction in planned collections and revenue in the periods
affected.
Cash Flows from Operating Activities. Net cash provided by operating activities
was $17.4 million for the nine months ended September 30, 2001, compared to
$12.4 million for the nine months ended September 30, 2002. The decrease in cash
and cash equivalents provided by operations was principally attributable to the
decrease in net income and activity included in 2001 that was non-recurring in
nature. Net income reported for the nine months ended September 30, 2001 was
$9.6 million versus $6.8 million for the nine months ended September 30, 2002,
for a decrease of $2.8 million. Additionally, in 2001, cash provided by
non-recurring operating activities included approximately $2.6 million in
restricted cash that was used to pay down debt pursuant to the Merger and $1.1
million from increases in accounts payable and accrued expenses related to costs
associated with the management of the accounts receivable acquired in the
Merger.
18
Cash Flows from Investing Activities. Net cash used in investing activities was
$24.0 million for the nine months ended September 30, 2001, compared to $10.8
million for the nine months ended September 30, 2002. Cash used in or provided
by investing activities is a function of the amount of accounts receivable
purchased, offset by collections applied to principal on purchased accounts
receivable. Collections applied to principal on purchased accounts receivable is
the difference between collections and revenue. Cash purchases of accounts
receivable were $38.9 million and $49.1 million in the nine months ended
September 30, 2001 and 2002, respectively, while the amount of collections
applied to principal on purchased accounts receivable were $26.0 million and
$40.3 million for the nine months ended September 30, 2001 and 2002,
respectively. Additionally, in the nine months ended September 30, 2002, $2.0
million in cash was used for the purchase of accounts receivable through our
investment in joint venture, and in the nine months ended September 30, 2001,
there were $11.1 million of pre-acquisition liabilities and related costs paid
in connection with the Merger.
Cash Flows from Financing Activities. Net cash provided by financing activities
was $13.1 million for the nine months ended September 30, 2001, compared to $2.6
million cash used in financing activities for the nine months ended September
30, 2002. Total borrowings under notes payable were $20.6 million for the nine
months ended September 30, 2002, representing the financing incurred to pay for
the Great Lakes portfolio in August 2002. Total repayments on the affiliate
revolving credit agreement and secured notes payable, including the Great Lakes
portfolio borrowings, for the nine months ended September 30, 2002 totaled $23.2
million. Total borrowings under the affiliate revolving credit agreement were
$47.1 million and repayments on notes payable totaled $35.4 million for the nine
months ended September 30, 2001. Borrowings in the first nine months of 2001
included the initial cost of the Merger, and repayments included the paydown of
certain notes payable and revolving credit facilities in connection with the
Merger. Additionally, in 2001, there was $2.3 million in proceeds from the
issuance of common stock at the time of the Merger. Fees paid to secure the NCO
Group sub-facility totaled $901,000 for the nine months ended September 30,
2001, and $77,000 was paid during the nine months ended September 30, 2002 in
connection with establishing the Great Lakes borrowing.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes and changes in corporate tax
rates. A material change in these rates could adversely affect our operating
results and cash flows. A 25 basis-point increase in interest rates could
increase our annual interest expense by $25,000 for each $10 million of variable
debt outstanding for the entire year. We retain an investment in securitization
with respect to its securitized accounts receivable which is a market risk
sensitive financial instrument held for purposes other than trading. This
investment exposes us to market risk, which may arise from changes in interest
and discount rates applicable to this investment. The impact of a 1% increase in
the discount rate used by us in the fair value calculations would not have a
material impact on our balance sheet as of September 30, 2002. There would be no
impact on our future cash flows. We do not invest in derivative financial or
commodity instruments.
Inflation
We believe that inflation has not had a material impact on our results of
operations for the three and nine months ended September 30, 2001 and 2002.
Item 4. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls. Within the 90 days
prior to the date of this Quarterly Report on Form 10-Q, the Company evaluated
the effectiveness of the design and operation of its "disclosure controls and
procedures" ("Disclosure Controls"). This evaluation ("Controls Evaluation") was
done under the supervision and with the participation of management, including
the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO").
19
Limitations on the Effectiveness of Controls. The Company's management,
including the CEO and CFO, does not expect that its Disclosure Controls or its
"internal controls and procedures for financial reporting" ("Internal Controls")
will prevent all error and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Conclusions. Based upon the Controls Evaluation, the CEO and CFO have concluded
that, to the best of their knowledge and subject to the limitations noted above,
the Disclosure Controls are effective to timely alert management to material
information relating to the Company during the period when its periodic reports
are being prepared.
In accord with SEC requirements, the CEO and CFO note that, to the best of their
knowledge, since the date of the Controls Evaluation to the date of this
Quarterly Report, there have been no significant changes in Internal Controls or
in other factors that could significantly affect Internal Controls, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
20
PART II
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in legal proceedings from time to time in the ordinary
course of its business. Management believes that none of these legal proceedings
will have a materially adverse effect on the financial condition or results of
operations of the Company.
Item 2. Changes in Securities and Use of Proceeds.
None - not applicable
Item 3. Defaults Upon Senior Securities
None - not applicable
Item 4. Submission of Matters to a Vote of Shareholders
None - not applicable
Item 5. Other Information
None - not applicable
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
10.1 Amendment No. 5 to Indenture and Servicing Agreement (Series 98-2)
Creditrust SPV 98-2, LLC, as Issuer and Wells Fargo Bank Minnesota,
National Association, as Trustee and Backup Servicer and Radian Asset
Assurance Inc. (f/k/a Asset Guaranty Insurance Company), as Note
Insurer and NCO Financial Systems, Inc. as Successor Servicer Dated
June 29, 2002.
10.2 Amendment No. 6 to Indenture and Servicing Agreement (Warehouse
Facility) Creditrust Funding I, LLC, as Issuer and Wells Fargo Bank
Minnesota, National Association, as Trustee and Backup Servicer and
Radian Asset Assurance Inc. (f/k/a Asset Guaranty Insurance Company),
as Note Insurer and NCO Financial Systems, Inc. as Successor Servicer
Dated June 29, 2002.
10.3 Credit Agreement by and between NCOP Lakes, Inc. as Borrower and CFSC
Capital Corp. XXXIV as Lender dated as of August 19, 2002.
10.4 Exclusivity Agreement related to Credit Agreement between NCOP Lakes,
Inc. (the Borrower) and CFSC Capital Corp. XXXIV (the Lender) dated as
of August 19, 2002.
10.5 First Amendment to Credit Agreement dated as of November 1, 2002, by
and between NCO Portfolio Management, Inc. (the "Borrower") and NCO
Group, Inc. (the "Lender").
99.1 Chief Executive Officer Certification Pursuant to U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Chief Financial Officer Certification Pursuant to U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(B) Reports on Form 8-K
NCO Portfolio filed an 8-K on July 8, 2002 Item 5 "Other Events" and Item 7
"Financial Statements and Exhibits".
NCO Portfolio filed an 8-K on August 16, 2002 Item 5 "Other Events" and Item 7
"Financial Statements and Exhibits".
NCO Portfolio filed an 8-K on August 23, 2002 Item 7 "Financial Statements and
Exhibits" and Item 9 "Regulation FD Disclosures".
NCO Portfolio filed an 8-K on September 19, 2002 Item 7 "Financial Statements
and Exhibits" and Item 9 "Regulation FD Disclosures".
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NCO PORTFOLIO MANAGEMENT, INC.
Date: November 14, 2002 By: /s/ MICHAEL J. BARRIST
-----------------------------------------------
Michael J. Barrist
Chairman, Chief Executive Officer,
and President
(Principal Executive Officer)
Date: November 14, 2002 By: /s/ RICHARD J. PALMER
-----------------------------------------------
Richard J. Palmer
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
22
CERTIFICATION
I, Michael J. Barrist, certify that:
1. I have reviewed this quarterly report on Form 10-Q of NCO Portfolio
Management, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
/s/ MICHAEL J. BARRIST
- ------------------------------------
Michael J. Barrist
Chairman, Chief Executive Officer,
and President
(Principal Executive Officer)
23
CERTIFICATION
I, Richard J. Palmer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of NCO Portfolio
Management, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 14, 2002
/s/ RICHARD J. PALMER
- ---------------------------------------------
Richard J. Palmer
Senior Vice President, Chief Financial
Officer and Treasurer
(Principal Financial and Accounting Officer)
24